With tons of speculation about the future of the OTC derivatives market and the need for financial reform and increased transparency, market practitioners are a great source for comments on the evolution of the market, how regulation will affect the market and what challenges reform will bring to financial institutions.
Recently we conducted an interview with Mr. Rohan Douglas, the CEO of Quantifi, a provider of valuation and risk management tools to the buy and sell-side.
1. Could you please briefly describe your career, especially in risk management? What is the role of your company, Quantifi, in the market place?
I started my career working for a primary bond market dealer in Australia in 1983. I joined Salomon Brothers which became part of Citi in 1990 and worked in Fulcrum and arbitrage research before running global credit derivatives and emerging markets trading research.
I founded Quantifi in 2002 with the goal to provide the same kind of advanced analytics, pricing and risk management tools used by the most sophisticated banks to the many new participants entering the OTC markets at that time. Our first products were Quantifi Toolkit (an analytics library) and Quantifi XL (XL add-ins). We introduced our trading and risk management system (Quantifi Risk) in 2005 and our counterparty solution (Quantifi Counterparty Risk) in 2010.
Since 2002, Quantifi has grown to become a leading provider of analytics, trading and risk management software for the global OTC Markets. We have a broad range of integrated pre-trade and post-trade analysis, pricing, structuring and risk management solutions, designed to enable top-tier financial institutions to better value, trade and risk manage a broad range of derivatives instruments. Our solutions allow clients to rapidly and accurately manage their exposures and respond more effectively to changing market conditions.
Our clients include many of the world’s most sophisticated financial firms including 5 of the 6 largest global banks, 2 of the 3 largest asset managers, leading hedge funds, insurance companies and other financial institutions.
2. What will be the impact of Basel III on OTC derivatives market and how will it change the landscape in the financial world in the years to come?
Basel III is set to have a profound impact on the OTC derivatives market in almost every aspect of operations and technology. Not only will it force many banks to transform their business models, it will also require them to undertake significant process and system changes. Some of the key impacts:
· New minimum capital rations will drive new methods of measuring and allocating capital as banks will be required to hold more capital and higher quality of capital to cover Credit Value Adjustment risk. There is therefore even more incentives for banks to implement CVA desks - however, there are major operational and practical challenges in setting up a CVA desk.
· The introduction of central clearing will have immediate and longer term impacts as it will require significant operational and system changes for post-trade operational processes
· Increased regulatory reporting will require significant reworking of legacy risk management systems to accommodate for further data requirements, new calculations to report and increased frequency and turnaround times.
3. The Financial engineering term has become an almost dirty word now. Which is the most important opportunity for risk specialists in the coming years?
There has been a trend towards simpler products which is likely to continue. At face value this may indicate a trend towards less financial engineering and simpler risk management but in reality, the current market and regulatory environment has meant that vanilla trades are now the new exotic. Valuing and risk managing even the simplest OTC products has become significantly more challenging and requires funding adjustments like OIS discounting and counterparty risk adjustments like CVA/DVA.
This significant increase in complexity for all aspects of trading and risk management raises the bar for risk specialists but presents a unique opportunity. Banks will increasingly be concerned about return on capital and as complexity widens the gap between the cost of internal builds and a vendor solution, banks will be more motivated to leverage vendor solutions that deliver the level of sophistication required while providing significantly lower capital investment and much greater business flexibility.
4. How can you verify that a specific risk management strategy is working?
P&L is the ultimate determinate. The key is to have the processes and systems you need in place before any market stress or unexpected event. Providing feedback as part of the process is important. This feedback should be in terms of capital cost, predicted behaviour Vs actual behaviour (with tools like P&L attribution), and historical analysis. Oversight is also important in terms of having the right corporate culture and responsibility in place.
5. What are the main lessons from the current crisis from your point of view and what are your projections of where we are heading to in terms of a new financial landscape?
The current crisis has spread rapidly from the financial markets to have severe and lasting impact on the real economy. One of the key lessons to be learnt is that market participants need to improve their understanding, application and management of their market and credit/counterparty risk. Having an understanding of history inevitably leads to an appreciation of the value of good management, processes, infrastructure, models and risk analysis. Having this in place takes effort and cost initially but makes things easier during the good times whilst at times of market turmoil firms are better positioned to take advantage of opportunities. This is an environment where Quantifi provides even more value to our clients by providing tools that deal smoothly with these challenges and allow them to focus on and respond immediately to market opportunities as well as risks. Other main lessons from my perspective centre on macroeconomic policy, financial regulation and the global financial architecture.
Even though regulatory uncertainty and market volatility continue to dominate the markets, there is a growing consensus and direction emerging for a new OTC market landscape. Key drivers of this landscape include counterparty risk, a new valuation framework adjusting for the cost of collateral agreements called OIS discounting and central clearing. Technology is playing an increasingly important role for the OTC markets and this trend is likely to accelerate with the introduction of central clearing. The complexity of the trading, operational, and risk management system required to support OTC businesses have dramatically increased.
6. How the GlobalRisk Community can contribute to the process of better understanding of complex world of risk?
Risk management is an increasingly important discipline. As risks in the financial markets increase, the importance of risk management to all aspects of a financial firms practices increase. Managing market, funding, regulatory, liquidity, operational and other risks involves the business model and risk appetite of a firm and needs to come from the board down. This is a huge change from even a few years ago.
As an online forum for risk professionals, GlobalRisk Community is a great resource for keeping market participants informed about the rapidly changing environment and developing best practices. By connecting practitioners and researchers it helps promote sound risk management standards and practices globally.
Your comments and questions are welcome.
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